How Costly is the Deliberate Disinflation in India? Estimating the Sacrifice Ratio

Ravindra H. Dholakia and Kadiyala Sri Virinchi

No WP2015-08-01, IIMA Working Papers from Indian Institute of Management Ahmedabad, Research and Publication Department

Abstract: Methods followed in earlier studies for estimating the sacrifice ratio or the real cost of deliberate disinflation have focused only on aggregate supply side ignoring aggregate demand. The present study considers the adjustment path obtained as a locus of short run equilibria to arrive at a theoretically acceptable sacrifice ratio. The study uses quarterly data from the period between 1996-97Q1--2013-14Q4 in India and employs both the regression as well as the direct methods to estimate the ratio. The results have revealed a sacrifice ratio ranging from 1.7 to 3.8 depending on the method and the measure of inflation used. Such a magnitude of the real cost of disinflation in India, also relevant in the long run, clearly contradict the dominant view among policymakers that the trade-off, if any, is negligible. Deliberate disinflation policy needs to consider the real cost of sacrificing output and employment particularly when its magnitude is substantial.

Date: 2015-08-06
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